Shanghai Ziyan Foods Co., Ltd.'s (SHSE:603057) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Shanghai Ziyan Foods (SHSE:603057) has had a great run on the share market with its stock up by a significant 9.5% over the last month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Shanghai Ziyan Foods' ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Shanghai Ziyan Foods

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Shanghai Ziyan Foods is:

18% = CN¥363m ÷ CN¥2.0b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.18 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Shanghai Ziyan Foods' Earnings Growth And 18% ROE

At first glance, Shanghai Ziyan Foods seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 8.0%. However, for some reason, the higher returns aren't reflected in Shanghai Ziyan Foods' meagre five year net income growth average of 3.4%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

As a next step, we compared Shanghai Ziyan Foods' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 1.6%.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Shanghai Ziyan Foods is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Ziyan Foods Making Efficient Use Of Its Profits?

Shanghai Ziyan Foods' very high three-year median payout ratio of 105% suggests that the company is paying its shareholders more than what it is earning and it definitely contributes to the low earnings growth seen by the company. That's a huge risk in our books. To know the 2 risks we have identified for Shanghai Ziyan Foods visit our risks dashboard for free.

Only recently, Shanghai Ziyan Foods started paying a dividend. This means that the management might have concluded that its shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 89%. As a result, Shanghai Ziyan Foods' ROE is not expected to change by much either, which we inferred from the analyst estimate of 21% for future ROE.

Summary

In total, it does look like Shanghai Ziyan Foods has some positive aspects to its business. Specifically, its high ROE which likely led to the growth in earnings. Bear in mind, the company reinvests little to none of its profits, which means that investors aren't necessarily reaping the full benefits of the high rate of return. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.